Wednesday, June 10, 2009

Julian Robertson’s genius in the yield steepener trade

Recently I mentioned Julian Robertson’s yield steepener trade. The yield steepener, which is a bet on rising long Treasury rates, is a really a bet on rising inflationary expectations.

This trade demonstrates Robertson’s genius. For most investors, a bet on inflation means a bet on gold, or other commodities. Here is what Robertson had to say about gold:

While Julian certainly thinks inflation is in our future, he is hesitant to buy gold. In the Value Investor Insight interview, he goes on to say that, "I've never been particularly comfortable with gold as an investment. Once it's discovered none of it is used up, to the point where they take it out of cadavers' mouths. It's less a supply/demand situation and more a psychological one - better a psychiatrist to invest in gold than me."

The bond market is infinitely more liquid
Whether the statement about being a psychiatrist is true or not, I don't know. For people like Robertson who run large hedge funds, liquidity is a far bigger concern. While mere mortal like us play around with gold (including the likes of John Paulson). Robertson has moved onto the far more liquid U.S. Treasury market.

To give you an idea of the differences in scale, the U.S. debt clock shows the total U.S. debt outstanding to be roughly $11 trillion. By contrast, Federal Reserve holdings of gold bullion (assuming that it’s not encumbered by gold loans) amount to a little over $200b, even at today’s prices. If we were to look at gold stocks, the total market capitalization of components of the Amex Gold Bugs Index (HUI) total about $120b, which is roughly the market capitalization of Cisco Systems (CSCO).

Robertson has enormous investment capacity in this trade, compared to investors who just play gold and gold stocks.

Now that’s genius.

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